Fannie Mae’s chief economist sees house prices falling by 6.7% over the next 2 years. These are the warning signs.
The real-estate sector is in a quandary.
The housing market was a wild rollercoaster ride that ended with a big fat splat last year, with mortgage rates doubling and demand plummeting.
Home sellers aren’t keen on listing their homes, given that they’ve recently secured an ultra-low mortgage rate. Home buyers, as a result, are struggling to find good options as the number of homes for sale remains low.
So where will the supply come from, to meet buyers’ demand? And what happens if a recession hits? Will home prices fall?
MarketWatch spoke with Doug Duncan, senior vice president and chief economist at Fannie Mae
in a video interview.
Duncan’s team, which is the economic and strategic research group at Fannie Mae, recently published its economic and housing forecast.
MarketWatch: What happens if the U.S. Federal Reserve raises interest rates to 5.5%? What does that mean for the housing market?
Duncan: The housing sector has a very well established relationship with monetary policy. It’s one of the most interest-rate sensitive sectors, if not the most interest rates in the sector.
We made our first call on the recession [to occur this year]. We looked ahead and we said, if things unfold over the next 9 to 12 months in the following way, we think we’ll have a mild recession in 2023. That looks like it’s a pretty good call. It’s possible it could be a soft landing.
Our base case is something in the neighborhood of a 0.5% to 1% decline in GDP over 2023.
“‘We think we’ll have a mild recession in 2023.’”
And part of the reason we expect it to be mild is housing because we haven’t solved the supply problem. Millennials are not done buying houses.
The demand-and-supply characteristics are there for a recovery if interest rates come down.
MarketWatch: We keep talking about this problem of not having enough homes on the market for sale, and that we aren’t building enough new homes. When will supply improve? Where will these homes come from?
Duncan: It’s gonna come from home builders, until boomers age to a level where they’re forced to give up their home.
One of the things about the boomers that they’ve been very consistent on, is [to say] we intend to age in place. The 75-plus portion of our population has a 78% homeownership rate. There’s a lot of owned homes in that population group.
And of course, they’re going to face mortality, as we all will. So that’s really the biggest driver of things related to mortality that will force them out of those homes that would put that back into supply.
But they’re a healthier group than generations before them. They’re living longer.
So that puts [supply] on the back of builders. But the builders are up against affordability issues from a development perspective because of local zoning issues.
MarketWatch: Are you concerned about this resistance to people returning to work, and the impact on commercial real estate?
“‘Businesses are going to evaluate remote work.’”
Duncan: Businesses are going to evaluate remote work, and they’re going to say, we’re letting workers work remote so that reduces their commuting costs, which is actually a real income gain for them. Because they don’t have to pay for the wear and tear of the car or the subway.
Not all [remote] workers are coming back to that space, and some of that space is going to be reduced in price or in value. And that will show up in defaults and delinquencies, or the sale of a property at a loss.
In the cities with a big central business district like San Francisco or New York City or Chicago, it might be more significant [than] say Indianapolis or Dallas or places where there’s a lot more developable land.
MarketWatch: You changed your forecast for housing. Now you expect home prices to fall 6.7% in the next two years, which is more than you previously estimated. What was the reason for that?
You can look and see where [houses] were withdrawn from availability and re-listed at a lower price. That gives you an idea of whether price declines are taking place in that market.
Markets that saw the most rapid appreciation are seeing the most rapid decline. You are probably seeing more declines in the San Jose area than in Indianapolis.
Households that bought recently are the ones that are probably at some risk, although when they bought, they probably got a very low interest rate. So they have to make a decision: Do I give up his 3.5% interest rate because prices fell 20%? Well, if I’m gonna live in the house, does it really matter?
This interview has been edited and condensed for style and clarity.
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Redfin CEO predicts 'terrible consolidation’ in the real-estate sector, but says it will ultimately be good for the industry
The real-estate sector is in crisis amid the housing downturn. Expect more pain to come before things start to normalize, one housing chief says.
But he added a caveat: “I do think it’ll be good for the industry.”
During the pandemic years of 2020 and 2021, many Americans jumped into the real-estate industry, Kelman recounted, so many that “we had more real-estate agents than listings by 2021.”
At this point, there are about million-and-a-half realtors trying to sell roughly over five million homes, meaning that they’re only doing five or six deals a year, which “isn’t a productive, fulfilling life,” Kelman said.
Some of the excess capacity in the sector has been released. In 2022, Redfin went through layoffs twice, responding to market conditions. Compass, another brokerage, announced a third round of layoffs on Thursday, to reduce expenses.
“I hope the industry is close to [becoming] right-sized and that things can get better from here,” Kelman said on Wednesday. “I don’t think that’s happened yet.”
‘It’s just a roommate generation now’
But for many Americans, high housing prices and mortgage rates make homeownership unaffordable. The Redfin chief executive sympathized with younger Americans priced out of the market.
“It’s just a roommate generation now, where people are staying with their parents, living in the basement or just shacking up with friends longer because home prices and rents have both gotten so far out of hand,” Kelman said.
There is some relief for those renters, as rents have fallen over the past few months.
Rents dropped for the fourth month in a row in December, Apartment List said in its monthly national rent report on Wednesday.
“Rents decreased in December in 90 of the nation’s largest 100 cities,’ the report stated, “with prices down by 3% month-over-month.”
And more homes are coming online to help with rental pressure.
But that’s also limiting the number of homes that go on sale, Kelman noted. He said that some of that supply came from home sellers who are withdrawing their listings from the market, and renting them out instead.
Investors still on the prowl for deals
Investor buying was a big topic of conversation during the pandemic, as many prospective buyers got beat out by companies and landlords with big pockets.
Kelman said that investors are still on the prowl, and are scouring disaster zones for deals.
In 2021, investors bought 24% of all single-family homes sold nationwide, a Pew Trusts report said last year.
Kelman said that some out-of-town investors today are tracking damaged homes, such as in Florida, to find deals.
When he recently visited a local office in Florida, Kelman said Redfin employees in areas affected by Hurricane Ian told him that investors were calling as the hurricane made landfall.
“We were trying to tour properties that the National Guard had closed …that were literally submerged. We would have had to visit the property by boat,” Kelman recounted.
“And these investors still wanted us to do a virtual tour where we’re using our phone to guide them through the property,” he continued.
“Even as the regular residents of Florida are calling us, almost in tears, because they’re standing on their second-floor balcony and they’re up to their knees and water …there’s another group of people coming from all over the world who see this as an investment opportunity,” he said.
While insurers and lenders are becoming wary of coastal properties that come with risks associated with climate change, such as flooding, “what was crazy to me is that investors were stepping in to fill that gap,” Kelman said.
Canada banning foreign homebuyers was ‘a bold move’
In response to investors’ buying frenzy, Canada, which is also dealing with an unaffordable housing market, decided to take a hard stance. Kelman said he was impressed.
At the start of 2023, the Canadian government enacted a ban on foreigners buying homes in Canada for two years. The law provides exceptions for purchases made by immigrants and permanent residents of Canada, CNN reported.
“I was impressed and shocked at what Canada did,” Kelman said.
“At one level, it’s just a massive self-inflicted wound to the economy,” he said. But on another level it’s “a real commitment to making housing more affordable for Canadians,” he added.
While the United States frets over a shortage in the supply of homes available for eager buyers, “Canada just said screw it. They pulled the cord,” Kelman said.
“And now that housing market is having a real correction and it’ll be terrible for the real-estate industry [and] for people who are about to sell their home,” he added.
“But it will mean that a new generation of Canadians is going to be able to afford a place, and so that was a pretty bold move,” he added.
Got thoughts on the housing market? Write to MarketWatch reporter Aarthi Swaminathan at firstname.lastname@example.org
If someone promises you the “deal of a lifetime,” it’s probably not a good investment.
That’s what finance guru Matthew Onofrio, who sold a program claiming to have cracked the code on commercial real estate, promised inexperienced investors looking to strike it rich. But prosecutors say it was all a fraud aimed at lining Onofrio’s pockets.
The 31-year-old native of Eau Claire, Wis., appeared on investing podcasts and at conferences with a compelling tale. He said he had walked away from a promising career as a nurse anesthetist when he discovered a real estate strategy known as triple net investing, through which he had amassed a portfolio worth over $150 million in just three years.
But between 2020 and August of this year, federal prosecutors in Minnesota say, Onofrio had ripped off numerous banks to the tune of $35 million by roping investors into a complex web of quick-flip real estate sales, fraudulent mortgage applications and doctored appraisals.
In a statement, Onofrio’s attorney, Marsh Halberg, said none of his client’s investors had been hurt financially by their investments.
“The defense is aware of very few, if any, transactions where the investors have suffered actual losses at his time. We believe most of the transactions with Mr. Onofrio still maintain a positive cash flow and /or an increase in the value of the property that was purchased,” Halberg wrote in an email.
A civil suit filed this year involving a radiologist from Puerto Rico named Matthew Hermann, who wanted to get involved in real estate investing with his wife, laid out how Onofrio operated.
The suit said the pair met at a networking conference in Colorado in 2020 and hit it off while discussing real estate opportunities. Hermann said he was hoping to build up a real estate portfolio that would provide him with enough income that he could stop working.
Hermann said in court papers that Onofrio offered to bring him into “the deal of a lifetime,” involving a commercial property for sale for $6.3 million in Minneapolis. All Hermann had to do was come up with $1.5 million for the down payment.
“Onofrio told Hermann that he won’t get to his goal of leaving his job by buying duplexes. Onofrio told him that ‘this will light gas on the fire of where you need to go’. He told Hermann that this is all about mindset’,” the court documents read.
When Hermann said he didn’t have that kind of money available, Onofrio offered to lend it to him so he could secure a bank loan for the purchase and Hermann agreed, the court filings said. What Onofrio didn’t say was that he had already reached a deal with the owners to buy the building for $4.75 million, not $6.3 million, and that the difference was going into his pocket, the suit claimed.
Hermann was then stuck paying nearly $6,000 a month in loan payments to Onofrio in addition to his bank loan.
“Onofrio pushed Hermann—a novice with real estate—into this purchase with grand promises of the deal of lifetime. The reality, though, was that Onofrio was the one assured to make money on the deal, not Hermann,” the papers read.
Hermann later tried to sell the property and said he found a buyer willing to pay $6.3 million for it, but the deal fell through due to litigation surrounding Onofrio’s loan.
Hermann’s attorney didn’t respond to a message seeking comment.
Federal prosecutors described a similar pattern, with Onofrio allegedly placing his own money into investors’ accounts to make their finances look better to lenders, and also fabricating appraisal documents to inflate the value of properties.
In one deal in 2021, a Minneapolis commercial property was sold three times in just five months, passing through more than one business entity Onofrio controlled. By the end of the string of transactions, the price had jumped by nearly $4 million, business publication Finance & Commerce reported.
Onofrio is charged with three counts of bank fraud and prosecutors say they are seeking the forfeiture of $35 million seized during the course of the investigation.
'Most economists are predicting a recession in 2023': I own a rental property. Is it a good time to take out a bank loan and renovate — or should I wait?
Along with a sibling, I own a rental property of more than 40 rooms in the Caribbean, where we do weekly rentals.
It’s near downtown but in need of repairs and renovation.
Is this a good time to go to the bank for a loan for renovation? We are also open to changing our business model.
Please advise and thanks.
Ready to Make a Move
‘The Big Move’ is a MarketWatch column looking at the ins and outs of real estate, from navigating the search for a new home to applying for a mortgage.
Do you have a question about buying or selling a home? Do you want to know where your next move should be? Email Aarthi Swaminathan at TheBigMove@marketwatch.com.
Nice job on maintaining and running this 40-room short-term rental. With the worst days of COVID behind us — I hope — travel is booming and people are going crazy exploring all parts of this planet. So proceed only if the demand for bookings is there.
I don’t know what lenders are offering where you are located, so take a couple of weeks to approach a bunch of lenders to see what rate they’re offering, and if that interest rate is trending downwards or upwards.
In the U.S., there has been some respite. The average 30-year fixed mortgage rate fell to 6.67% last week from 6.9%, according to the latest data from the Mortgage Bankers Association. But that’s roughly twice the rate for the same time last year.
Obviously, the faster you repair this property and spruce it up, the sooner you’ll increase its value. And you can likely up the daily rate you charge. But I advise you to proceed cautiously, and only if your rental projections make sense.
There are other considerations: You may have to keep some of the rooms out of the roster when they’re going go through a facelift, but at the end of the day, you should see more money once it’s done. Put your financial plan through a rigorous risk-assessment, and account for all eventualities — existing demand, expected increase in demand post-renovations, and a drop in demand due to a possible recession.
You will need to have enough financial support to weather all three outcomes. With the help of an accountant and/or financial adviser, make sure you have the cash flow, rental projections — including the assumed increase in rent post-renovation — to survive the next 12 months, particularly if there is a slowdown in the market.
Given that inflation is slowly coming under control, as per the federal government’s report on Nov. 10, the way the 10-year Treasury is moving down, and mortgage rates are falling again, you may be approaching a window of opportunity open up in the near-term.
“The decrease in mortgage rates should improve the purchasing power of prospective homebuyers, who have been largely sidelined as mortgage rates have more than doubled in the past year,” Joel Kan, vice president and deputy chief economist of the Mortgage Bankers Association, said earlier this week.
“As a result of the drop in mortgage rates, both purchase and refinance applications picked up slightly last week,” he added. “However, refinance activity is still more than 80% below last year’s pace.”
Another option: Do the renovations during the off-peak season when foot traffic will likely be lower. Guests obviously won’t appreciate hammering and drilling, and you don’t want to end up with a spate of negative reviews on Airbnb
You also mentioned being open to changing your business model. If you’ve got an appetite for it, consider converting some of the rooms into long-term rentals. If you get a good mix of short- and long-term renters, you will have a more secure balance in terms of cash flow.
You appear to have done an amazing job weathering the two years of COVID, where you likely saw bookings fall off a cliff.
Now that the industry is in recovery mode, it’s an opportune time to make sure you get the most out of your property. But again make sure you can afford it, especially if business slows down, and factor in any delays due to shortage of labor and/or materials. Ask your builder for references from recent clients, so you can get more details on what challenges they faced.
Most economists are predicting a recession in 2023. As with everything in business, there are no guarantees.
By emailing your questions, you agree to having them published anonymously on MarketWatch. By submitting your story to Dow Jones & Company, the publisher of MarketWatch, you understand and agree that we may use your story, or versions of it, in all media and platforms, including via third parties.
House prices will fall in 2023, but affordability will be at its worst since 1985, says Capital Economics
Home prices will fall next year by 8%, as mortgage rates and a recession will continue to hurt affordability, a new report says.
The report by Capital Economics, published this month, which outlines its outlook for housing over next year, warned that sales will slump and housing prices will fall.
With lending standards still tight, and affordability poised to worsen, expect purchasing power to deteriorate, and housing prices to fall by 8% by mid-2023, the group said.
“Given that we are unlikely to see an improvement in affordability anytime soon, many buyers will be priced out of the market, while others will simply be unwilling to make a purchase,” the group stated in their report.
“As bidders become scarcer, market power will shift further from sellers to buyers,” they added.
Sellers, currently sitting on homes enjoying ultra-low mortgage rates, will be forced to accept lower prices over the next year, Capital Economics said. After home prices fall 8% in mid-2023, compared to this year, expect price growth to recover to 2.5% by the end of 2024, they added.
“After home prices fall 8% in mid-2023, compared to this year, expect price growth to recover to 2.5% by the end of 2024.”
Capital Economics also expects mortgage rates to “hold close to 7% over the remainder of next year” which means affordability will be at its worst since 1985.
For a household with a median income buying a median-priced home, the mortgage payment as a share of income rose to 28.5% in October 2022 from 13.3% in May 2020, the group said.
(The median listing price for a home in the U.S. is currently $425,000, up 13% over the last 12 months, according to Realtor.com. Realtor.com is operated by News Corp subsidiary Move Inc., and MarketWatch is a unit of Dow Jones, which is also a subsidiary of News Corp.
Mortgage rates will go back down to 5.75% by the end of 2023, they forecasted.
The group also expects the U.S. economy to fall into a “mild recession” in 2023, and expects single-family sales to fall to the lowest level since 2011. It also expects single-family starts, or construction of single-family homes, to fall to the lowest level since 2014. The market will recover in 2024, they added.
Even though prices are expected to fall, people are likely to still find it hard to afford to buy a home, and more buyers will likely spill over into the rental market, Capital Economics added.
Some good news: Expect a surge in new supply next year as well, as builders complete construction on homes, which will prompt rents to fall 0.5% in 2023, they forecasted.
Got thoughts on the housing market? Write to MarketWatch reporter Aarthi Swaminathan at email@example.com
Home prices will fall in 2023, but affordability will be at its worst since 1985, research firm says
Home prices will fall by 8% next year, but high mortgage rates and a possible recession will continue to hurt affordability, a new report says.
In a report published this month, independent research firm Capital Economics warned that sales will slump and housing prices will fall over the coming year.
With lending standards still tight and affordability poised to worsen, consumers should expect their purchasing power to deteriorate even as housing prices fall, the group said.
“Given that we are unlikely to see an improvement in affordability anytime soon, many buyers will be priced out of the market, while others will simply be unwilling to make a purchase,” the report stated. “As bidders become scarcer, market power will shift further from sellers to buyers.”
Sellers, many of whom now have mortgages with ultralow rates, will be forced to accept lower prices over the next year, the research firm said. After mid-2023, when Capital Economics forecasts home prices to fall by 8% compared with this year, consumers can expect price growth to recover to 2.5% by the end of 2024.
“ “As bidders become scarcer, market power will shift further from sellers to buyers.” ”
The group also expects mortgage rates to “hold close to 7% over the remainder of next year,” which means affordability will be at its worst since 1985.
For a median-income household buying a median-priced home, the mortgage payment as a share of income rose to 28.5% in October 2022 from 13.3% in May 2020, the group said.
The median listing price for a home in the U.S. is currently $425,000, up 13% over the last 12 months, according to Realtor.com. (Realtor.com is operated by News Corp subsidiary Move Inc., and MarketWatch is a unit of Dow Jones, which is also a subsidiary of News Corp.
Mortgage rates will go back down to 5.75% by the end of 2023, the Capital Economics researchers forecast in the report.
The group also expects that the U.S. economy will fall into a “mild recession” in 2023 and that sales of single-family homes will fall to the lowest level since 2011. It also expects single-family-home starts, or new construction, to fall to the lowest level since 2014. The market will recover in 2024, the report said.
Even though prices are expected to fall, people may still find it hard to afford to buy a home, meaning that more prospective buyers will likely move into the rental market, the report noted.
Some good news: Buyers can expect a surge in new supply next year as builders complete construction on homes, which will prompt rents to fall 0.5% in 2023, the report said.
Got thoughts on the housing market? Write to MarketWatch reporter Aarthi Swaminathan at firstname.lastname@example.org
Realtors expect 'vulnerable' commercial real-estate prices to drop in 2023 — as people embrace hybrid working practices
Realtors are turning bearish on commercial real estate.
Well, technically — the National Realtors Association (NAR) said it’s expecting the commercial real-estate market to experience a “slight decline in prices” in 2023.
“Nationwide, we are beginning to see some decline in commercial appraisal values,” Lawrence Yun, chief economist at NAR, said over the weekend.
“Cap rates simply cannot match up with higher borrowing costs, especially among people who need to refinance their properties,” he added. “However, strong job growth is supporting prices in many markets.”
Cap rate refers to the capitalization rate, which is used to calculate the expected rate of return for a property, be it residential or commercial. The cap rate is calculated by dividing a property’s net income by its asset value.
With interest rates rising sharply over the last few months, that’s increased borrowing costs, and in turn forced cap rates up, Yun explained, and pushed property values downwards as a result.
“Offices are the most vulnerable to these price decreases,” Yun said.
“We are seeing a rise in office vacancies in many cities, driven by a preference for remote work,” he added. Before the pandemic, San Francisco saw an office vacancy rate of just 6%, he noted. Now, it’s more than 15%.
According to Green Street’s commercial property-price index, rising rates have pushed property prices down by 13% from a peak this year.
“It’s a simple story: higher yields on Treasury bonds equals higher cap rates,” Peter Rothemund, co-head of strategic research at Green Street, said in a statement.
Offices saw a drop in prices of 17.5%, the company said in its report.
“And as large as the decline in pricing has been, I don’t think we’re out of the woods,” he added. “If the 10-year note stays above 4%, property prices are likely to keep falling.”
And while some bosses like Elon Musk are trying to get people back into the office, it’s unlikely that employees will return fully to the office like the days before the pandemic, the NAR said.
Employees will spend 25% to 35% less time in the office than they did before the pandemic, Matt Vance, senior director and Americas head of multifamily research and senior economist for CBRE, said.
That translates to about a day, to a day and a half less in the office, he estimated. And “we believe this will translate to a 15% reduction in office space demand per employee,” Vance said.
Got thoughts on the housing market? Write to MarketWatch reporter Aarthi Swaminathan at email@example.com
By Joshua Kirby
Puma SE said Friday that Arne Freundt will take over as chief executive officer at the beginning of the new year, replacing Bjorn Gulden, who will leave the company.
Mr. Freundt, currently chief commercial officer, will be given a mandate of four years as CEO beginning Jan. 1, Puma said.
Incumbent Mr. Gulden’s tenure as a member of the German sportswear firm’s management board will meanwhile expire at the end of the year, the company said.
Puma shares fell after the news, trading down 7.5% to EUR43.00 as of 1348 GMT.
Mr. Gulden said he had taken the decision not to renew his contract after nine years at the helm. “I felt it was the right time for Puma, my successor and me to leave now,” he said, adding that he wished to continue his career in an operational role.
Mr. Freundt, who has been with the company for more than 10 years, has always been a part of setting strategy and making big decisions, Mr. Gulden said.
The new CEO “has been a designated candidate and is the ideal choice to continue Puma’s very successful path and to further accelerate the Company’s momentum,” Supervisory Board Chair Heloise Temple-Boyer said.
Mr. Freundt will be one of two new CEOs at German sporting-goods companies next year. Larger rival Adidas AG’s chief Kasper Rorsted is set to hand over the reins of the company to a successor at some point in 2023, after a string of disappointing results and guidance cuts.
Write to Joshua Kirby at firstname.lastname@example.org; @joshualeokirby
‘My son is not careful with money’: I want to rescue him from his ‘tiny’ 800-square-foot apartment. Should I buy him a home, and have him sign a promissory note?
I have an adult son who is 27 years old and works in the tech industry. I love my son, but he is not disciplined when it comes to money. He has been living in an 800-square-foot apartment in one of the most expensive cities in the U.S. Buying a place on his own is out of the question given his salary, current property prices and rising interest rates.
My solution to rescue my son from his tiny apartment is to buy a house for him. He is not married. I want him to sign a promissory note and pay me back interest-free over the next 20 years. I want to somehow insert this promissory notice into the title so that he will not be able to sell the house without my consent. Also, if he does not keep up with his payments I will have recourse to take action. I am 99.99% sure that all my concerns will end up groundless, but I want to have this in writing to be sure.
“‘I am 99.99% sure that all my concerns will end up groundless, but I want to have this in writing to be sure.’”
His monthly payments will be important but not critical to my daily life. I have more than enough money to cover my expenses, but it is important for me not to create an opportunity — even to the most innocent mind — for doing something silly. I want to be fair to my son, who has been a very good kid, but I do not want to compromise too much during my own retirement years. I have been working since I was 14 years of age (I’m now over 65), and I recently retired comfortably.
Is this a good plan? Should I proceed with it? Is such a promissory note sufficient, and can that be inserted into the title in the same way a lien works? My son is not careful with money. I hope that this process teaches him a bit of financial responsibility and that his quality of life improves significantly. That is my main objective.
Please let me know what you think.
For many young people living in big cities in 2023, an 800-square-foot apartment would be an absolute luxury.
It’s safest to make financial decisions with a cool head and a steely resolve. Of course you love your son, but you should not allow emotion to rule your finances. This will be one of the biggest purchases — if not the biggest — you make in your lifetime, and you will be relying on a third party to pay the bills. Seek legal and financial advice before promising anything.
You would need to arrange — with a real-estate attorney — a promissory/mortgage note and a deed of trust. The former outlines the terms of the loan: the interest rate (0% in this case), when each payment is due, the length of the loan, etc. The latter establishes that your son is obligated to repay the loan and outlines exactly what happens if he defaults.
Alternatively, you could reduce your financial commitment by giving your son a down payment or paying for a portion of the house so that the mortgage repayments are within his reach, cosigning on the loan and putting both your names on the deed. With the 30-year interest rate edging closer to 7%, however, this may be a less attractive option.
If you did cosign on a mortgage with your son and you contributed to the closing costs, that contribution could be viewed by the Internal Revenue Service as a gift if it’s more than the annual exemption ($17,000 for an individual in 2023). Under current rules, an individual may give away $12.92 million in assets or property over the course of their lifetime.
Neil Carbone, trusts and estates attorney at Farrell Fritz, said you could provide your son with an intrafamily mortgage loan. “Intrafamily loans can be good estate-planning vehicles because the interest on such a loan is generally lower than can be obtained through a commercial lender,” he says.
“The interest rate will typically be set at the AFR, or applicable federal rate, which is the lowest rate that can be charged without the loan being considered a gift. Another benefit of an intrafamily loan is that the repayment terms can be more flexible than a commercial lender may be willing to provide. “
For example, the loan can provide for payments of interest only for a period of time, with a balloon payment at the end, he says, and the loan must be carefully documented and the mortgage will be listed as a lien against the property, so you will have protection if your son fails to make the payments.
“‘This gift would change his life and show him how fortunate he is to have such a generous father, and he should — in theory — change his ways. Unfortunately, however, life rarely works like that.’”
This gift would change his life and show him how fortunate he is to have such a generous father, and he should — in theory — change his ways. Unfortunately, however, life rarely works like that. Financially reckless people don’t change overnight and, if the years I have spent writing this column have shown me anything, it’s that free gifts rarely spark a complete transformation.
In fact, they risk doing the opposite. Free gifts often have the capacity to seem like a reward for imprudent behavior. Although you expect your son to meet his monthly obligations, as any landlord will tell you, you should prepare yourself for a missed payment here and a missed payment there, or for 90% of the payment one month and 100% the next, followed by 70% the next.
You should ask your son some questions before you go ahead with this: Has he paid off his credit-card debt? Does he have six months’ worth of emergency savings? Would he submit to a monthly “wallet check” over a period of six months to make sure he can stick to a budget and resist the temptation to overspend? Would he agree to meet with a financial planner?
You should also meet with a financial planner to “stress test” your finances. How would a default affect your credit? Will you incur a gift tax? What if you had a medical emergency or needed long-term care? From what you say in your letter, your son may not be in a position to help you out. Do you have long-term care insurance?
And be prepared for the unexpected. Home values generally go up over time, but they can also fall without warning. The housing market has been on a tear for the last three years, but there could come a time when property values fall and the house is worth less than what you paid for it, or less than what you owe if you decide to take out a mortgage.
Alternatively, you could create a trust for your son’s benefit and put the house in that trust, and make a gift of cash to the trust, which could be used to purchase the house, Carbone adds, and as a beneficiary of the trust, your son could be permitted to live in the house rent-free provided that he pay for the upkeep of the house. (Or, preferably, charge him rent and ask him to be responsible for the upkeep, so it keeps him accountable and also helps with your own cash flow.)
Hard knocks, learning from past financial mistakes and wins, and appreciating the value of a dollar by working hard for what he has — along with advice from a financial adviser and trusted attorney — are far more likely to help your son than the proverbial gift horse. Your son, like millions of people his age, is living in a small apartment and getting a sharp dose of reality.
It is, regrettably perhaps, a rite of passage. But it will help build character and allow him to appreciate any steps he takes up the property ladder in the future. He may even look back on this part of his life fondly. The gift of a house should be more than a way to teach him a bit of financial responsibility. And I’m not sure it will help him in that endeavor. In fact, I recommend you have him meet a series of financial goals before you decide to sign on the dotted line.
You have the opportunity to give your son a head start, but I hope that he also learns how to stand on his own two feet.
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